Get ready for the collapse of Saudi Arabia.

19 February 2016 3:27 pm

Saudi Arabia isn’t really a state at all, it’s a corrupt business held together by income from oil. The guaranteed supply of oil has guaranteed Saudi security and allowed Washington to ignore autocratic practices, human rights abuses and the export of Wahhabi extremism.

But that might change with the collapse in the oil price.

Standard & Poor’s has cut Saudi Arabia’s credit rating to A- from A+ with S&P saying the decline in oil prices will have “a marked and lasting impact” on the economy of the biggest Opec producer. The Saudi downgrade comes less than four months after S&P cut the kingdom’s credit rating one level to A+ in late October, when Brent crude was selling for around $50 a barrel. It’s now selling for around $30.

The collapse in the price of oil tells us that Saudi Arabia is a political enterprise with what has to ultimately be an unsustainable business model.The bottom line is that Saudi Arabia operates more as a "family business" than an actual state. It's one where the king, aka the CEO, converts oil into payoffs to buy political and military loyalty. The system is corrupt and cannot endure.

Saudi Arabia’s finances have never been famous for their transparency. We know it has some of the lowest production costs in the world, but it also has huge expenses and virtually no other sources of income. For Saudi Arabia, it’s all about oil.
And that’s a problem because even on official figures, the country ran a budget deficit of close to $100 billion last year, amid the falling oil price. And with the oil price still plummeting and despite cuts, this year it unlikely to be much better. That amounts to 15 per cent of gross domestic product. That makes Greece look frugal. The Saudis have plenty of assets to fall back on but they have a problem: when you are spending 15 per cent more than you earn every year you burn through a lot of cash very quickly.

The February 16 announcement of a Saudi-Russian freeze at very high January levels may reflect a need for cash as does talk of a Saudi-Aramco IPO.

To cover its deficit, the Kingdom has been selling its stock of foreign exchange. Reserves worth $746bn in August 2014 have now fallen to $646bn. The IMF predicted last year that it would run out of foreign exchange reserves in just five years.

Saudi Arabia also has the ticking time bomb of a potential generational powder keg to worry about. Youth unemployment is high. Almost a third of 15 to 24-year-olds out of work. And with almost half of Saudi’s 31 million population under 24, the potential for unrest if living standards are squeezed is obvious.

What happens when the price of loyalty rises and a ravenous elite doesn't limit its appetite now that oil prices keep dropping? The monarchy will face political insolvency.

War and glorious foreign policies are always a popular option among the desperate to direct attention away from themselves. One war against Yemen is already in progress and the monarchy has hinted that it will fight in Syria as well.

Saudi Arabia would not be the first country to fall to a combination of war and cheap oil. In the 1980s, the Soviet Union, embroiled in a costly conflict in Afghanistan and facing an increasingly discontented population at home, was on its last legs. An oil crash, which saw prices fall from just over $100 per barrel (in today’s dollars) at the start of the decade to just over $20 by 1986, contributed in large part to the Soviet collapse three years later.

We might be seeing history repeat itself.